15 May 2013

In brief: Major reform of the Vietnamese retail industry will likely provide greater opportunities for foreign investment in one of the most attractive investment destinations for global retailers. Partner Robert Fish (view CV), Senior Associate Linh Bui and Lawyers Chi Ha and Mai Loan Nguyen report.

How does it affect you?

The key changes introduced by the new regulations on foreign investment in the distribution and retail sector in Vietnam are:

significantly, for the first time, foreign invested enterprises (FIEs) may be exempted from the economic needs test (ENT) process when opening additional retail outlets of less than 500 sqm in size located in designated areas for trading activities;

a clearer licensing process and new guidelines regarding the establishment of an Economic Needs Assessment Committee will help to improve transparency in the overall licensing process;

greater certainty around regulatory treatment of foreign investment in an existing Vietnamese trading business, with simpler procedures to obtain licences for existing retail outlets; and

a specific rule to permit FIEs to export goods that have been imported into Vietnam.

Vietnam committed to opening up its retail industry for foreign investment when it joined the World Trade Organization (the WTO) in 2007. In 2008, it topped a global chart as the most attractive investment destination for retailers and remained a 'hot' location for the following years, thanks to a rising level of disposable income and young demographic of its 87 million population.

Yet institutional barriers, especially in the licensing process for FIEs, remained a huge hindrance to developments in this industry. Coupled with unfavourable economic conditions following the global financial crisis, these factors have sent Vietnam off the global list of top 30 retail markets last year. This, in turn, created pressure on the Government to reform the rules surrounding foreign investments on retail and distribution activities. The issue of Circular 08/2013/TT-BCT (Circular 08) by the Ministry of Industry and Trade (the MOIT) on 22 April 2013 is seen to be a significant attempt to bring back foreign investors' confidence in the market and boost foreign investment in this sector.

Circular 08 provides detailed regulations on import, export and trading of goods by FIEs in Vietnam and will become effective from 7 June 2013. It replaces Circular 09/2007/TT-BTM (Circular 09), previously issued in July 2007, on the same subject. While the subject is not new, Circular 08 sets out more specific rules on the licensing process and the assessment process of the ENT that a FIE would have to go through in order to conduct its trading business or open additional retail outlets in Vietnam.

The prescriptive requirements and processes described in Circular 08 can be seen as onerous but are likely to be regarded as a positive development by many foreign investors and stakeholders familiar with the Vietnamese legal system. This is because the lack of details in Circular 09 often resulted in practical difficulties in obtaining the necessary regulatory approvals and licences for investments in this industry, as the process was not transparent to foreign investors.

Significant exemption from the ENT process for retail outlets of 500 sqm or less in designated areas

Retailing or, more broadly, distribution activities with respect to goods is a conditional sector for foreign investment in Vietnam. This means that FIEs will have to apply for a business licence that specifically allows them to undertake such activities in Vietnam.

In addition, under the WTO commitments of Vietnam, FIEs licensed for retail activities are only initially permitted to set up one retail outlet. Establishment of additional outlets is subject to an ENT assessment by the licensing authorities, based on certain criteria, including the number of existing retail outlets, stability of the market, population density and size of the provincial area where the additional outlet is proposed to be established.

In an unprecedented development, Circular 08 provides an exemption for certain retail outlets from the application of the ENT process. Specifically, it states that the requirement to satisfy the ENT does not apply in the case of establishing additional retail outlets with a size of 500 sqm or less in 'an area which has been approved under the provincial planning for trading activities of goods and has completed infrastructure'. The exemption will no longer be available if the approved planning is subsequently changed so that this condition is not satisfied. In addition, the requirement for FIEs to obtain a retail licence for each individual retail outlet will still apply, despite this exemption from the ENT process.

The wording of Circular 08 seems to indicate that the exemption covers areas such as shopping centres, office buildings, or city areas that have been approved as a designated area for trading or retailing activities. In that case, any retail outlet may be set up by an FIE in the established area without having to go through the ENT assessment process if it does not exceed the cap in size. This may cover any standard retail shops and stalls, small- to medium-sized specialised stores, convenience stores and small-sized supermarkets.

Once implemented, this exemption is likely to stir up foreign investments in the retail sector, as FIEs may be able to embrace a more aggressive expansion or market penetration plan. Foreign investors should remain vigilant to, and monitor any development in relation to, the actual application of this provision by the regulators in the coming period.

Clearer licensing and ENT assessment process

Circular 08 sets out in detail the documentary requirements for the business licence application for distribution and retail activities and the process by which the ENT assessment would be carried out, with an aim to provide more transparency to the licensing process. This is especially useful, since guidance was limited in previous regulations, and indeed was totally absent in Circular 09 with respect to the ENT process.

It is now envisaged that, under Circular 08, an Economic Needs Assessment Committee (the ENAC) will be established by the licensing body (generally the People's Committee (the PC) of the province where the additional outlet is proposed to be located) to determine whether the additional outlet meets the ENT criteria. The ENAC will have representatives from different regulating bodies at the relevant provincial level, including the PC, the Department of Planning and Investment, the Department of Industry and Trade and other related authorities whose opinion is relevant, as determined by the PC Chairman. The ENAC's recommendation will be submitted to the PC for approval, which will then become part of an application dossier to be sent to the MOIT for its regulatory opinion on the establishment of the additional retail outlet.

The main concern arising from the above process, as described in Circular 08, is that there is no indication of timing for the recommendation by the ENAC and preliminary approval at the PC level. As these are pre-application steps, the statutory timeline set out in Decree 23/2007/ND-CP after a PC receives an application dossier from the relevant FIE does not appear to cover this preliminary process. Therefore, the effectiveness of the ENAC will need to be tested in the coming period. In our experience, this is likely to vary, depending on the relevant PC, and may be challenging, as it will require significant oversight from the PC to coordinate activities across different regulating bodies.

Application of the rules to foreign investment in existing Vietnamese trading businesses

Compared to FIEs, local fully-Vietnamese-owned companies are not generally required to apply for a business licence to undertake trading businesses. They are also not subject to the ENT process described above in opening multiple retail outlets.

One of the key questions in recent times was what happens when a foreign investor acquires shares or interests in an existing Vietnamese trading company with a number of existing retail outlets. Circular 08 provides an answer to this question and confirms that, upon foreign acquisition, the Vietnamese trading company will be treated as an FIE and will become subject to the additional licensing procedures and requirements set out in Decree 23 and Circular 08. More significantly, since a FIE is merely defined as 'a Vietnamese enterprise with foreign invested capital' under the Law on Investment, Circular 08 can be interpreted to mean that even a 1 per cent foreign acquisition will lead to this result. There are arguments that, based on other regulations (albeit lower ranking than the Law on Investment), the threshold for foreign investment should be
49 per cent to trigger the application of the above regulations. In any case, in light of Circular 08, closing of an acquisition may require additional complicated licensing steps and the business activities of the Vietnamese trading company may be unnecessarily restricted following the foreign acquisition.

There appears to be a concession in Circular 08 for these transactions in that the newly converted FIE will be subject to a shorter and simpler licensing process in respect of its existing retail outlets. In particular, it appears that the new FIE is not required to go through the process for ENAC recommendation in order to obtain licences for retail outlets that have been validly established before acquisition by foreign investors. This concessional treatment, if adopted by the regulating bodies in practice, seems to be a reasonable application and an important carve-out that will ease the regulatory process for undertaking an M&A transaction in the retailing/trading sector.

Right of FIEs to export imported goods

The export right of FIEs in existing regulations is often expressed generally as the right to purchase goods (that do not belong to the prohibited categories) in Vietnam to export to overseas markets. This was susceptible to a narrow interpretation by the regulatory bodies to goods 'manufactured in Vietnam'. In our experience, such a view had unduly restricted the flexibility of large FIEs in their trading activities.

A FIE who had imported finished goods faced significant difficulties in trying to export the surplus goods out of Vietnam when market conditions in Vietnam changed or when there were opportunities to sell them at a higher price in neighbouring markets. These difficulties also arose with respect to attempts to export goods, which had been imported by other Vietnamese companies, that the FIE could source and purchase in Vietnam. As such, it was not practically possible for large FIEs in Vietnam to act as a hub to import goods and/or export goods to other countries in the region.

This situation is corrected in Circular 08, in which the right of an FIE to export goods that have been imported by the FIE or by other Vietnamese entities is clearly enshrined, provided that all import tax and financial obligations have been paid. Such clarification is welcome and will help to enhance the competitiveness of Vietnam in the regional distribution map.

Increased government scrutiny in performance of existing business operation

An interesting observation coming out from Circular 08 is the increased level of government scrutiny in the performance of existing business operation by FIEs. This is evident in the new, but almost universal, requirement that the application dossier (for business licences to import, export, undertake trading activities or establish additional retail outlets) will have to include evidence from a tax authority with respect to satisfaction of corporate income tax obligations in the immediately preceding two years before submission of the relevant application.

Circular 08 does not assign any particular relevance to such evidence, nor explain how losses incurred by an existing trading subsidiary of a foreign investor or by a current retail outlet of a FIE will affect the decision whether to grant a business licence to a new activity or a new establishment. However, this appears to signal that the government is seeking to improve transparency and information exchange between the tax authority and other regulating bodies. It also may start to anticipate evidence of a profitable trading business before giving its approval for an expansion of such activities, which, in part, may be a reflection of current concerns of alleged transfer pricing by FIEs.

As with everything in Vietnam, it will take a while to assess the implications of Circular 08 in practice and any positive effects that it may bring. On a preliminary note, however, we consider that the detailed guidelines in Circular 08 will reduce existing difficulties and uncertainties around treatment of FIEs in trading business and promote more transparency in the relevant licensing process. The ENT exemption provided for small- and medium-sized retail outlets is a significant development that is likely to be embraced by foreign investors.

Indeed, we are particularly excited to see that there has been an increasing level of activity reported in newspapers in this sector, as foreign investors have started to realise renewed opportunities with active new market entries and expansion plans across the whole country. The time for a re-emergence of Vietnam in the global retail world map may perhaps begin now.

To assist with better understanding of the changes in Circular 08, as well as the twists and tweaks that foreign investors may encounter in investing in the retail and trading sector, Allens will hold seminars, hosted by the Australian Chamber of Commerce, in Ho Chi Minh City and Hanoi in June. We hope to see you there and answer any questions that you may have about your business in Vietnam.